Claire Trott: The dangers of overpaying pension contributions

One of the key issues to arise from all the changes to pension input periods, annual allowance and money purchase annual allowances is knowing what to pay and when. My fear is that we are going to go back to the days of processing hundreds of contributions on 5 April each year, as overpayment of contributions can have unexpected consequences, especially if your employer pays them all.

Establishing earnings

The taper of the annual allowance all hinges on the amount of taxable income someone receives in the tax year. They have to pay the contributions in that tax year or lose the tax relief.

With this in mind, they will probably have to make assumptions about what their earnings will be or wait until as near to the end of the tax year as possible in order to try and avoid overpaying.

This will be even more difficult in a final salary scheme where they cannot opt out and then opt back in once they have worked out if they are going to get an annual allowance charge.

It should not be forgotten that even if an employer pays contributions on the member’s behalf these are included in the annual allowance calculation and could take them over, causing a charge despite the fact they have not personally received any tax relief on the contribution.

Even those who do not need to worry about the taper might need to consider contribution levels if their net relevant earnings are not high enough to justify their personal contributions.

This can often be the case if they receive the majority of their income in the form of dividends. In this instance, it is likely to be better for the contributions to be paid by the employer because they do not need to be tested against earnings, only the annual allowance.

Carry forward

Carry forward can also add to the complexities because, although you can carry forward any unused annual allowance from the previous three years, you must have earnings to support the tax relief clamed in the year in which the contributions are actually paid. You cannot carry forward unused tax relief from previous years.

Refunds of contributions

Unless in the case of a “genuine error” – such as a bank paying the contribution to the pension scheme by accident or someone forgetting to cancel the standing order or direct debit in time – it is not possible for a pension scheme to just send the money back. If the client was misadvised to pay the contribution by a professional such as an accountant, it was still paid deliberately and would be an unauthorised member payment should it be refunded by the scheme. This is not the scheme being difficult but simply just following the rules – even if we do not agree with them.

Should contributions be paid that are in excess of the member’s net relevant earnings then it is possible to make a refund to the member. However, it is not the same as unwinding the contribution. The original amount paid and any tax relief reclaimed will be set against the annual allowance, so may use up allowances that would have been available for carry forward in the future or use up previous carry forward. It is possible it could even cause a tax charge if the annual allowance is exceeded. It is worth remembering, however, that you do have six years in which to request a refund of excess contributions.

It is always wise to be careful contributions paid are correct at the time so that there is no need to pay an annual allowance charge. That said, there will be circumstances where a client is still better off having a contribution in excess of the annual allowance: usually where the employer is not going to offer other benefits in exchange for reduced pension contributions. Remember, the growth will generally be tax-free and that could be for 40 years or more if they are lucky.